Chilean-type capital controls: A building block of the new international financial architecture?
Taxes on short-term capital flows such as introduced in Chile and Slovenia during the 1990s in the form of unremunerated reserve requirements (URRs) on financial credits are under discussion as a remedy against adverse effects of volatile international capital flows. From a theoretical point of view, URRs find support from the fact that financial markets react faster to exogenous shocks than goods markets. A high volatility of capital flows, in turn, may reduce investment and exports, and thus negatively affect overall growth. A tax designed to reduce inflows of (short-term) capital and to enhance the autonomy of domestic monetary policy may therefore raise welfare. Yet, the effectiveness of URRs is limited because capital controls can at best delay but not prevent speculative attacks on misaligned currencies. Moreover, a temporary introduction of capital controls, as is often proposed in the case of an acute financial crisis, may have the adverse effect of increasing rather than lowering financial market volatility. The empirical evidence from Chile and Slovenia shows that URRs are no panacea and that the gain in monetary autonomy has been limited. While the composition of inflows has changed towards flows exempted from the URR, the overall inflow of capital has increased, and interest rate effects have been short-lived. There is no evidence that the volatility of capital flows has declined. Exchange rate volatility seems to have come down, albeit possibly as a result of exchange market intervention. Capital controls are often proposed as a tool to promote the stability of the financial sector. More specifically, it is often argued that external financial liberalization should proceed only after sufficient progress has been made in reforming the domestic banking system. Yet, the administrative capacity to enforce capital controls is typically weak precisely in those countries which have poorly supervised and thus potentially unstable banking systems. Also, foreign competition can enhance the efficiency of the domestic financial sector. Thus, progressing simultaneously on internal and external financial liberalization seems the preferable option. At the time of opening up for foreign capital, minimum prudential standards should be in place. Also, public deposit guarantees should have been abolished in order to limit the risk of overborrowing and moral hazard. The imposition of capital controls may even send negative signals to investors and thus affect investment negatively. Exposure to external shocks should rather be reduced by pursuing structural reforms, by following sound macroeconomic policies, by disseminating clear and transparent information, and by using market mechanisms to alter the structure of foreign debt. This also allows for a more efficient use of scarce administrative resources. In this context, international institutions have an important role to play in designing and enforcing an institutional framework in which such mechanisms can be implemented.
|Date of creation:||1999|
|Date of revision:|
|Contact details of provider:|| Postal: Kiellinie 66, D-24105 Kiel|
Phone: +49 431 8814-1
Fax: +49 431 8814528
Web page: http://www.ifw-kiel.de/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Eichengreen, Barry & Tobin, James & Wyplosz, Charles, 1995.
"Two Cases for Sand in the Wheels of International Finance,"
Royal Economic Society, vol. 105(428), pages 162-72, January.
- Barry Eichengreen, James Tobin, and Charles Wyplosz., 1994. "Two Cases for Sand in the Wheels of International Finance," Center for International and Development Economics Research (CIDER) Working Papers C94-045, University of California at Berkeley.
- Robert E. Lipsey & Robert C. Feenstra & Carl H. Hahn & George N. Hatsopoulos, 1999.
"The Role of Foreign Direct Investment in International Capital Flows,"
in: International Capital Flows, pages 307-362
National Bureau of Economic Research, Inc.
- Robert E. Lipsey, 2000. "The Role of Foreign Direct Investment in International Capital Flows," NBER Working Papers 7094, National Bureau of Economic Research, Inc.
- Garber, Peter & Taylor, Mark P, 1995. "Sand in the Wheels of Foreign Exchange Markets: A Sceptical Note," Economic Journal, Royal Economic Society, vol. 105(428), pages 173-80, January.
- Pierre-Richard AgÃ©nor & Jagdeep S. Bhandari & Robert P. Flood, 1992. "Speculative Attacks and Models of Balance of Payments Crises," IMF Staff Papers, Palgrave Macmillan, vol. 39(2), pages 357-394, June.
- Bartolini, Leonardo & Drazen, Allan, 1997.
"Capital-Account Liberalization as a Signal,"
American Economic Review,
American Economic Association, vol. 87(1), pages 138-54, March.
- Buch, Claudia M. & Heinrich, Ralph P. & Pierdzioch, Christian, 1998. "Taxing short-term capital flows - An option for transition economies?," Kiel Discussion Papers 321, Kiel Institute for the World Economy (IfW).
- Maurice Obstfeld, 1994. "The Logic of Currency Crises," NBER Working Papers 4640, National Bureau of Economic Research, Inc.
- Ronald I. McKinnon & Huw Pill, 1996. "Credible Liberalizations and International Capital Flows: The "Overborrowing Syndrome"," NBER Chapters, in: Financial Deregulation and Integration in East Asia, NBER-EASE Volume 5, pages 7-50 National Bureau of Economic Research, Inc.
- Joshua Aizenman, 1998.
"Capital Mobility in a Second Best World -- Moral Hazard With Costly Financial Intermediation,"
NBER Working Papers
6703, National Bureau of Economic Research, Inc.
- Joshua Aizenman, 2003. "Capital Mobility In A Second--Best World: Moral Hazard With Costly Financial Intermediation," Review of International Economics, Wiley Blackwell, vol. 11(1), pages 1-17, February.
- Salvador ValdÃ©s-Prieto & Marcelo Soto, 1998. "The Effectiveness of Capital Controls: Theory and Evidence from Chile," Empirica, Springer, vol. 25(2), pages 133-164, January.
- Döpke, Jörg & Pierdzioch, Christian, 1998. "Brokers and business cycles: Does financial market volatility cause real fluctuations?," Kiel Working Papers 899, Kiel Institute for the World Economy (IfW).
- Sebastian Edwards, 1998.
"Capital Flows, Real Exchange Rates, and Capital Controls: Some Latin American Experiences,"
NBER Working Papers
6800, National Bureau of Economic Research, Inc.
- Sebastian Edwards, 2000. "Capital Flows, Real Exchange Rates, and Capital Controls: Some Latin American Experiences," NBER Chapters, in: Capital Flows and the Emerging Economies: Theory, Evidence, and Controversies, pages 197-246 National Bureau of Economic Research, Inc.
- Sebastian Edwards, 1998. "Interest Rate Volatility, Capital Controls, and Contagion," NBER Working Papers 6756, National Bureau of Economic Research, Inc.
- Van Wijnbergen, Sweder, 1985. "Trade reform, aggregate investment and capital flight : On credibility and the value of information," Economics Letters, Elsevier, vol. 19(4), pages 369-372.
When requesting a correction, please mention this item's handle: RePEc:zbw:ifwkdp:350. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (ZBW - German National Library of Economics)
If references are entirely missing, you can add them using this form.